Pension Lump Sum Amount Changed by -15% in 1 month

[FabricStache]

I'm in the process to taking a lump sum payment of my pension from a previous employer.  When I started the process last month, they told me the lump sum would be $41K.  A few days ago I got another letter stating that there was a change in the interest rate that lowered my amount to $35K.  This is a -15% difference!  Seems like interest rates can't swing that much.  Has anyone experienced this?  Or know if there were any significant change in interest rates in the last month that would cause this?

I did call to inquire and am waiting for a detailed calculation from the benefits department.

[dandarc]

I'm in the process to taking a lump sum payment of my pension from a previous employer.  When I started the process last month, they told me the lump sum would be $41K.  A few days ago I got another letter stating that there was a change in the interest rate that lowered my amount to $35K.  This is a -15% difference!  Seems like interest rates can't swing that much.  Has anyone experienced this?  Or know if there were any significant change in interest rates in the last month that would cause this?

I did call to inquire and am waiting for a detailed calculation from the benefits department.

1.  Rising interest rates would lower the lump sum.

2.  How old are you?  I'm sure your expected payout-time of the pension goes into this as well.  If you're taking the lump sum at 35 vs. say 65, a relatively small change in the interest rate could have a large effect due to compounding over a sufficiently long time.

[FabricStache]

1.  Rising interest rates would lower the lump sum.

2.  How old are you?  I'm sure your expected payout-time of the pension goes into this as well.  If you're taking the lump sum at 35 vs. say 65, a relatively small change in the interest rate could have a large effect due to compounding over a sufficiently long time.
[/quote]

1. Yes, interest rates can change but this is a significant amount in a very short period.

2. Good guess.  I'm 35.  The age that I'm taking it only changed by a month between the 2 calculations because they couldn't process the transaction right away.  They did the calculations when I first initiated the process.  Than then again when it was closer to being finalized.

[dandarc]

So more questions - if you were to not take the lump sum, does the monthly payout start immediately?  Or is this more of a - take a lump sum now or monthly payments will start when you reach age X.  Maybe X = 60?

The way you do this type of calculation is called a present value analysis.  So what is this stream of monthly payments that may not even start for 25 years worth today?

A couple of examples from excel.  Assumptions are 25 years until you start getting payments, and payments expected to continue for 25 years after they start (rough analog for life expectancy).  The only thing that changes is the discount rate.

Rate	0.035	0.0394
Years to payments start	25	25
expected years of payments	25	25
Monthly amount	491.76	491.76
PV	41000.33	35067.43

So you can see that the interest rate went up by only 0.44%, but the effect is the roughly $6K or 15% difference when compounded over a long time period.

The formula in that bottom row is:

Code: [Select]

=PV(B1/12,B2*12,0,-PV(B1/12,B3*12,-B4))if you want to try this for yourself.

[dandarc]

Another way to think of this -

in a defined-contribution plan (maybe a 401K), you know what the account is worth today - it is whatever is in the account.  What you don't know is what that account will buy in the future.

In a traditional defined-benefit pension, you don't know what it is worth today, but you do know what it will pay out in the future.

To even offer a lump sum, they've got to jump through some hoops to make the defined-benefit plan look like a defined-contribution plan.  An assumption has to be made about the returns on the investments to do this.  The plan documents will spell out how that happens.  It is likely tied to a benchmark rate of some kind - maybe it is the 10-year T-Bill yield on a particular day of each month + (or -) some %.  Or something similar.

In your particular case, maybe there is a legal remedy if it was the employer that screwed up by not processing in a timely fashion?  I doubt they did the math wrong though.

[FabricStache]

Thanks dandarc.  I really didn't know how the amount was calculated.  Thanks for the calculation.  I natively thought that the lump sum value would stay the same or grow, not decline.  I've been tracking the pension lump sum value for years and I've never seen it go down.  Well, this is bad news for me. :(  It's not a ton of money in the scheme of my investment portfolio, but it's not pocket change either.

[deborah]

Talk to HR about the difference and what they had told you it would be. When I left work a similar thing happened, but because they had already quoted me an amount, and they mucked me up by not processing it immediately, they honoured the higher amount. It is possible that they could also come good for you.

[ZiziPB]

Is the pension a "defined benefit" or a "defined contribution" plan (the latter is sometimes also called "cash balance")?  Do you have access to the plan documents?  The documents should spell out how the lump sum is calculated.

[FabricStache]

Is the pension a "defined benefit" or a "defined contribution" plan (the latter is sometimes also called "cash balance")?  Do you have access to the plan documents?  The documents should spell out how the lump sum is calculated.

Thanks for the suggestion on finding the plan document.  I didn't even think to look for these.  I'm on a cash balance formula.  Below is the interest portion since they're obviously not giving me any more pay credits.  The way I understood it, the interest rate shouldn't have changed since it's an annual number determined in November.  Do I have this right?

Interest Credits
In addition to pay credits, your cash balance account also grows each month through interest
credits. Interest credits are:
• Applied to the amount in your cash balance account at the beginning of each month
• Allocated to your account at the end of each month
• Based on the effective annual interest rate of the five-year Treasury note as of the last
business day of November of the previous year, plus 0.25%. It will not be less than 3%
or more than 10%.
Please note: The amount of interest your account earns is subject to change from year to
year. Interest credits will continue to be allocated to your account after June 30, 2012 until
you begin to receive benefits from the Plan.

[greatrussian]

For a cash balance plan - the lump sum should be equal to the cash balance. Was any part of your benefit from a traditional defined benefit plan?

Prior to the Pension Protection Act of 2006, there was a requirement to project the cash balance out to age 65, convert it into an annuity, and then convert it back into a lump sum using IRS specified interest rates. This was called a whipsaw calculation, and it could result in large changes in lump sum amount as the interest changes occurred.

[Financial.Velociraptor]

Ouch!

I went FIRE at 40 and thought I was going cash out a 15k defined benefit plan.  Turns out, I can't touch a dime until 55!  You have to read the plan documents because they can full of a lot of surprises, especially if you are not using the plan as intended e.g. taking distribution after 55.

[ZiziPB]

Hmm, with a cash balance formula, your lump sump should only go up, never down.  So you really need to probe them some more on why this significant change.  The change in the interest rates would only affect the balance going forward not backwards.  And based on your documents and what the interest rates have been over the last few years, you should have been getting 3% per year on it for while.  In other words, the rate defaulted to a minimum a long time ago, there should have been no recent change.

[FabricStache]

For a cash balance plan - the lump sum should be equal to the cash balance. Was any part of your benefit from a traditional defined benefit plan?

Prior to the Pension Protection Act of 2006, there was a requirement to project the cash balance out to age 65, convert it into an annuity, and then convert it back into a lump sum using IRS specified interest rates. This was called a whipsaw calculation, and it could result in large changes in lump sum amount as the interest changes occurred.

I don't know if it's a traditional defined benefit plan but it is a defined benefit plan.  Wording from the pension document below.  I did have the pension in 2004 but unfortunately I didn't track the amounts back then to see if there was any re-calculation in 2006.

Type of Plan: The xxxx Retirement Plan is a defined benefit plan. This means that your
benefit is based on a formula. No individual accounts are established on behalf of
participants.

[FabricStache]

Hmm, with a cash balance formula, your lump sump should only go up, never down.  So you really need to probe them some more on why this significant change.  The change in the interest rates would only affect the balance going forward not backwards.  And based on your documents and what the interest rates have been over the last few years, you should have been getting 3% per year on it for while.  In other words, the rate defaulted to a minimum a long time ago, there should have been no recent change.

It looks like I've been getting a +0.25% increase monthly since I left the company.  The amount has always grown.  I've never seen it decrease, that's why I was so alarmed with the final pay out was significantly lower.  I have requested they provide me with the exact calculations used.

[greatrussian]

A traditional defined benefit plan is one where the final benefit is based on your pay when you leave the company, multiplied by a percentage per year worked. E.g. if you worked for 10 years, and the formula defines 1% of pay per year worked, you would receive 10% of your final pay every year.

A cash balance plan is a hybrid defined benefit plan. Meaning, it combines the features of the traditional defined benefit plan, and a defined contribution plan (like a 401(k)).

I'm curious to see how your lump sum was calculated. As mentioned previously, for a cash balance, the lump sum should be the notional account balance.

[FabricStache]

A traditional defined benefit plan is one where the final benefit is based on your pay when you leave the company, multiplied by a percentage per year worked. E.g. if you worked for 10 years, and the formula defines 1% of pay per year worked, you would receive 10% of your final pay every year.

A cash balance plan is a hybrid defined benefit plan. Meaning, it combines the features of the traditional defined benefit plan, and a defined contribution plan (like a 401(k)).

I'm curious to see how your lump sum was calculated. As mentioned previously, for a cash balance, the lump sum should be the notional account balance.

I think what you're referring to is the Final Average Pay formula.  This is not the calculation for me.  I worked for a very large global conglomerate that formed through several mergers or acquisitions.  The plan has a lot of complexities according to which previous company someone had worked for, if they were grandfather from their previous plan etc.  I'm on the cash balance formula.

The pay credit portion is paid each month I was employed at a rate of 4% in my case until July 2012 when they stop paying pay credits for all employees on the cash balance formula.

I will dig out old pay stubs to see if I can go back and do the math myself to see what my final amount should be.

[FabricStache]

I got the calculation for the plan broken down by month. I had also done the calculations myself. Turns out the different amounts had nothing to do with interest rates, like they letter had stated.  They had used the wrong percentage in the pay credit calculations from 2005-2010.  They were using 5% of pay when it should have been 4%.  So I should be receiving the lower amount and this error has been aging for almost a decade. :(

Well that was a wild goose chase.  On the bright side I'm pretty proud of myself for figuring the plan math. :)

Thanks to everyone for helping me out.

[dandarc]

Wow - wasn't expecting that.  So you really got screwed on the timing.  Wonder if they're going to try and claw-back money from anyone who recieved an erroneous lump-sum in the last few years . . .

I had something weird happen when leaving a particular employer.  Rolled over the retirement accounts to IRAs.  Then for 2 or 3 years, I was seeing additional small rollover amounts, including a random $200 check that was sent to my house.  Never did find out what was going on, but it has finally stopped at least.